Home Equity Loan Risk: One Retired Couple’s Tragic Situation And Why I Couldn’t Help Them

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What’s it like to be in your late eighties, in declining health, without a dime in the bank, and facing foreclosure? Sadly, I had the chance to find out. Here’s one woman’s unfortunate situation and how it serves as a case study for home equity loan risk in retirement. 

Norma’s Bad Situation

Let me introduce you to a woman we’ll call Norma, who was 88 at the time (if I remember correctly). Her husband, who we’ll call Fred, was just a few years older.

Norma’s health wasn’t great, but she could mostly get around OK. Fred, on the other hand, was in bad shape. He could barely do the basics like eating and using the bathroom on his own.

Fred’s health was in rapid decline and it fell to Norma to care for him. They didn’t have the money to hire professional care and they had no family living nearby. 

Norma’s devotion to Fred’s care was inspiring, but I could tell it was a big burden for her.

As we chatted, I also learned that Norma and Fred’s finances were a complete disaster. They were buried under a heap of medical bills and had two mortgage payments.

The main mortgage was a traditional 30-year fixed with a low rate and manageable payments. The second mortgage, however, was a home equity line of credit, or HELOC that they used as a safety net for unexpected expenses.

I shudder when seniors on fixed incomes tell me they have HELOCs because I know what a ticking time bomb they can be. It didn’t surprise me when Norma said the payment had recently increased by hundreds of dollars and they were now struggling to pay it.

Unfortunately, Norma and Fred were a case study in home equity loan risk.

Home Equity Loan Risk in Retirement

So why did the HELOC payment increase? The answer is simple: that’s how HELOCs work.

HELOCs usually have adjustable rates and interest-only payments. When rates increase, the payments increase as well. As you borrow more, your payment also increases.

The HELOC is a good loan product, but it’s risky for retirees on a fixed income. Unfortunately, many accountants, attorneys, and financial advisors still recommend HELOCs to retirees.

You see, Fred and Norma’s HELOC was now past the draw period, which usually lasts for the first ten years. They were no longer allowed to draw on the available credit or make a low interest-only payment anymore. When the draw period ends, the lender “recasts” the payment to force a complete pay back of the balance over the remaining loan term. Their monthly payment was now triple what it used to be.

Norma and Fred were already on a tight budget. Their income wasn’t keeping up with the rising cost of living, so their finances were already tight before the HELOC payment increased. There was no way they could afford the higher payment.

Tragically, Norma and Fred were now facing the very real possibility of losing their home. Chatting with Norma that day, I discovered what it’s like to be in your late eighties, in poor health, dead broke, and facing foreclosure.

Too Many Bills and Not Enough Options

If you’re young and healthy, you have the time and energy to recover from financial setbacks. But what does somebody in Norma’s situation do? She couldn’t get a job or start a business to make more money.

She also couldn’t refinance to consolidate her mortgages because she had limited income and her credit was shot. Her family wasn’t coming to the rescue either; they lived far away and had limited financial resources themselves.

What options does somebody in Norma’s situation have? Unfortunately, not many.

Norma and Fred’s best bet was probably to sell the home, use the remaining equity to pay off their bills, and rent a cheap apartment somewhere. That’s probably not what they envisioned for their retirement, but what choice did they have?

I wish I could say there was a positive resolution to this story, but there was not. I tried to help Norma and Fred eliminate their mortgage payments with a reverse mortgage, but they didn’t qualify for enough to settle both loan balances.

A HECM reverse mortgage offers a portion of the home’s value based on age and current interest rates. Unfortunately, the amount of money available via the HECM was lower than what it would take to pay off both mortgages.

Fred and Norma would have needed to come up with cash to pay down their mortgages to make the HECM work. Obviously, that wasn’t an option in their situation.

I wish Norma and Fred had chosen a reverse mortgage instead of a HELOC. They could have eliminated the payment on their main mortgage and accessed additional equity for unexpected expenses.

No payments are required as long as at least one of them lived in the home and paid the required property charges. They would have remained the owners of their home and they still could have left it to their kids.

Unfortunately, it was not to be. The HELOC (that many accountants, financial advisors, and attorneys still recommend) was likely going to cost them their house.

If they instead had a reverse mortgage (which many accountants, financial advisors, and attorneys still consider “risky” for some crazy reason), they could have lived securely in their home for years to come with no home equity loan risk.

The risk of HELOCs in retirement are interest-only payments, adjustable rates, and the recast at the end of the draw period, which can cause your payment to double or triple. The most significant HELOC risk in retirement is foreclosure because of the recast.

Some Important Lessons About HELOC Risk

Working with Fred and Norma highlighted a few important lessons that I want to pass on to you:

  1. Home equity loan risk in retirement is real. HELOC risks are high for retirees living on a fixed income. The more you borrow, the bigger your payment. HELOCs also usually have variable interest rates that are based on the prime rate. If the prime rate increases, your payment will increase as well. And let’s not forget the recast, which can double or triple your payment. A HECM line of credit is a far better option. You have all the flexibility of the HELOC, but without the risk of HELOCs. No payments are required on a HECM line of credit as long as you live in the home and pay the required property charges.
  2. There will be a time in your life when you have no capacity to increase your income. You need to have your financial resources already in place before that time comes. Home equity can be part of the picture as well, but I wouldn’t recommend using a HELOC. As you can see from Norma’s situation, the HELOC risks are too high if you’re on a fixed income.
  3. Your expenses will likely increase substantially late in retirement as your health declines. You may need to pay for in-home care if you can’t take care of yourself or a family member. You may have a lot of medical bills even if you have Medicare and a decent supplemental policy.
  4. Mortgage payments in retirement can be risky. Even if the payment is manageable at the start of your retirement, it won’t necessarily stay that way over years or decades. Inflation will constantly erode the purchasing power of your income. Even if the mortgage payment itself never changes, your other living expenses likely will. Property taxes and homeowner’s insurance also tend to increase over time. You don’t want to end up in a situation where you have to choose between paying the mortgage or critical medical care.
  5. It’s important to have multiple financial resources at your disposal. Hopefully you retire with a free and clear home. If so, get a HECM line of credit early in retirement to serve as an additional cash source. Hopefully you don’t need the money right away, which means you can let it grow and compound based on a guaranteed growth rate. By the time you do need the money, you’ll have a lot more at your disposal. The HECM line of credit offers the convenience and flexibility of HELOCs without the payment risk of HELOCs. If you retire with a mortgage, consider using the HECM to get rid of the payment. You can then build your savings faster and position yourself to more easily absorb unexpected expenses and/or higher medical costs in the future.
  6. The best time to get a reverse mortgage is when you don’t need it. It’s hard to get insurance on a house that’s already burning down, right? Likewise, it’s often hard to qualify for a reverse mortgage when you really, really need one. The best time to get a reverse mortgage is before you need it. If you’re desperate, your finances and credit may be too far gone to qualify.

Not a Loan of Last Resort

Norma and Fred, unfortunately, chose to follow the conventional wisdom, which is to use a HELOC for emergency cash in retirement. Unfortunately for them, the risks of a HELOC are many: adjustable rates, interest-only payments, and the recast, which can cause the payment to double or triple. Now they’re facing the very real prospect of losing their home.

Despite the HELOC risks, many financial professionals still recommend HELOCs instead of reverse mortgages. Somehow they think the risk of reverse mortgages is high and the risk of HELOCs is low.

I think this is why many financial professionals think the reverse mortgage is a loan of last resort only for broke and desperate people. I also think Norma and Fred’s situation disproves that notion. It’s not as easy to qualify for a reverse mortgage today as it used to be.

The reverse mortgage may have been a loan of last resort in the past, but it’s not today. If you’re seeking a reverse mortgage because you’re broke and desperate, it might already be too late. A reverse mortgage works best when it’s set up before you need it.

Frequently Asked Questions

What is the risk of taking a home equity loan?

Home equity loan risks vary depending on the type of home equity loan you have. Many home equity loans have fixed rates and fixed payments. If your payment is affordable, the only risk is that you owe more than your home is worth if home values fall. If you have a HELOC, you have the added home equity loan risks of adjustable-rates, interest-only payments, and the recast at the end of the draw period, which can cause your payment to double or triple.

Can you lose your home on a home equity loan?

Home equity loan risks vary depending on the type of home equity loan you have. Many home equity loans have fixed rates and fixed payments. If your payment is affordable, the risk of losing your home is probably minimal. If you have a HELOC, you have the added home equity loan risks of adjustable-rates, interest-only payments, and the recast at the end of the draw period, which can cause your payment to double or triple. If you can’t afford the new higher HELOC payment, you could lose your home.

Why is taking equity out of your home a bad idea?

The risk of home equity loans and HELOCs is that you increase the amount you owe on your home. If home values fall, you could owe more than your home is worth. If you need to sell your home, you’ll need to come up with the shortage out of pocket or negotiate a short sale with your lender.

What is not a good use of a home equity loan?

The risk of home equity loans and HELOCs is that you increase the amount you owe on your home. If home values fall, you could owe more than your home is worth. If you need to sell your home, you’ll need to come up with the shortage out of pocket or negotiate a short sale with your lender. In our opinion, a bad use of a home equity loan is anything for it which it won’t be repaid quickly. If you can’t repay it quickly, it’s probably a bad idea to take out the home equity loan – regardless of what you plan to use it for.

Mike Roberts Avatar
About Mike Roberts

Mike Roberts is the founder of MyHECM.com, a published author, and a highly experienced mortgage industry veteran with over a decade of mortgage banking experience. When he's not working, he enjoys spending time with his family, skiing, camping, traveling, or reading a good book. Roberts is the author of The Reverse Mortgage Revealed: An Industry Insider’s Guide to the Reverse Mortgage, which is available on Amazon.

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